Email Newsletter + Free Ebook

52 Great Ecommerce Ideas

Equity Crowdfunding Stalls

When President Obama signed the Jumpstart Our Business Startups Act in April 2012, the clock started ticking on a 270-day period for the Securities and Exchange Commission to write the regulations that would govern crowdfunding. That 270 period is over and no regulations exist. SEC Chairwoman Mary Schapiro, never a proponent of crowdfunding, quit her job at the end of 2012 after taking a very deliberate approach to formulating the rules. Three top deputies, one of whom was charged with overseeing the writing of the rules, also left. It is now generally thought that the rules will not be finished until the end of 2013 and equity crowdfunding will not start until early 2014.

Affluent Investors Only

In anticipation of the SEC promulgating regulations within the mandated timeframe, a number of equity crowdfunding websites actually went live in 2012, encouraging entrepreneurs to ready their crowdfunding campaigns. Now, several are finding creative ways to work within the current law that allows only accredited investors — those with a net worth of over $1 million or income over $200,000 for the previous two years — to fund businesses. One, CircleUp, which is focusing on the food industry, has partnered with SecondMarket, a registered trader which links accredited investors with investment opportunities via an online platform and WR Hambrecht, a registered broker dealer. CircleUp has also partnered with AngelList, a group of influential angel investors such as Reid Hoffman, founder of LinkedIn, who focus on technology investments. Another company, EarlyShares has joined with broker dealer Point Capital Partners.

CircleUp is a crowdfunding site that relies on accredited — affluent — investors.

One advantage of the broker dealer partnerships with crowdfunding sites is that if the funding is open only to accredited investors, the size of the raise can be anywhere from $100,000 to $5 million. In contrast, the equity crowdfunding law restricts start-ups from raising more than $1 million per year.

While many of these relationships may be temporary — letting crowdfunding sites show some momentum while waiting for the regulations to be adopted — others may continue, offering entrepreneurs a mix of accredited investors who can make larger investments with the non-accredited investors who would be able to invest smaller sums. However, accredited investors may balk at diluting their investment by sharing rights with large numbers of small investment partners and pull out of these arrangements when equity crowdfunding starts.

A Good Year for Donation Based Crowdfunding

Meanwhile, donation-based crowdfunding experienced a stellar performance in 2012. Kickstarter alone funded 18,109 projects with 2.2 million people pledging a total of almost $320 million to campaigns. Other crowdfunding sites have not made their totals available.

While some donation-based sites may enter the equity side once the rules are in place, others say they find the restrictions required by the law too onerous. In 2012, several technology projects raised substantially more funds that the $1 million per year limit. And there is certainly an advantage to not have to answer to investors and dilute ownership in a company.

Kickstarter facilitated over $300 million of donation funding in 2012.

The Need for Alternative Funding Mechanisms

The delay in equity crowdfunding is particularly problematic at this time because other funding sources are not readily accessible. Bank loans for start-ups and small businesses dried up several years ago. Venture capitalists have lost their appetite for new funding after seeing many of their high-profile investments — Facebook and Zynga for example — go bad after the companies went public. Investment research firm CB Insights says that many start-ups that received seed money will be unable to move to the next level — Series A funding. “The process of natural selection that will happen with seed companies, and which we’d argue should happen, will result in over 1,000 recently funded seed companies being orphaned, i.e. unable to raise follow-on financing. This will result in over $1 billion of investment into these companies being incinerated,” according to the firm. The segment taking the brunt of this funding shortfall will be Internet start-ups because they have attracted the highest percentage of seed money. These are the kinds of companies that could benefit from equity crowdfunding if it were available.

Equity crowdfunding is a threat to the venture capital industry, at least for the start-up segment that needs a modest amount of Series A funding. While it could also be a threat to angel investors, some of them have sought out a cooperative arrangement with emergent equity crowdfunding companies.

Although the SEC says that the delay in promulgating rules is because it wants to ensure that potential equity crowdfunding investors are protected from fraud, the SEC and VC firms have voiced the opinion that non-accredited individuals have no place in the risky world of investment. In 2013 it will be interesting to see if a federal agency and VC firms can thwart the intent of legislation passed by Congress.

Practical Ecommerce is an independent, family-owned, online magazine in Traverse City, Michigan, U.S. We are not affiliated with any e-commerce service, platform, or provider. Our mission is to publish authoritative articles, commentary, webinars, and podcasts to help online merchants.